An inheritance tax is a tax on a beneficiary’s receipt of assets from a deceased person. This article explores how inheritance taxes work generally.
Inheritance Tax Overview
An inheritance tax is a tax on a beneficiary’s receipt of assets from a deceased person. The beneficiary pays the tax as a percentage of the assets inherited. Rates generally vary based on the relationship between the estate owner and the beneficiary.
How Does It Work?
When a person dies, their assets are distributed according to the terms of their will or revocable trust, or if they did not have a will or revocable trust, according to the state’s laws. Depending on the value of the assets and the beneficiary’s relationship to the deceased, these gifts may be subject to inheritance tax.
There is no federal inheritance tax, but some states have their own inheritance taxes. However, even in states with an inheritance tax, spouses and, in most cases, children are exempt. Often, specific types of assets are exempt from inheritance tax as well.
Which States Impose an Inheritance Tax?
The five states that impose an inheritance tax are:
- Pennsylvania
- Maryland
- Nebraska
- Kentucky
- New Jersey
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What is the Inheritance Tax in Pennsylvania?
The tax rate is determined by the relationship between the decedent and the beneficiary and the type of assets they are passing on. Pennsylvania inheritance tax rates for residents are:
- 0% on transfers to a surviving spouse or to a child aged 21 or younger.
- 4.5% on transfers to direct descendants and people directly related to someone in a direct line of descent, such as a child (over age 21) or a grandchild.
- 12% on transfers to siblings.
- 15% on transfers to other heirs, except charitable organizations, exempt institutions, and government entities exempt from tax (which are not subject to tax).
In addition to the flat rate, there are also exemptions for certain types of assets. For example, property used for agricultural purposes is exempt from the inheritance tax in Pennsylvania.
Pennsylvania Inheritance Tax Example
An example will help illustrate. Let’s say Bob was a Pennsylvania resident who passed away, leaving his $4 million estate to his childhood best friend Jon. Because Jon isn’t a family member, he would be responsible for paying a $600,000 tax on the inheritance. On the other hand, if Jon was Bob’s 20-year-old son, he would be able to inherit the $4 million without paying any inheritance tax.
What’s the Difference between an Inheritance Tax and an Estate Tax?
An inheritance tax and an estate tax are similar in the sense that both are taxes on the transfer of assets to a deceased person’s heirs. But they work differently. An estate tax is imposed on the estate of the deceased person, and it is calculated on the total value of the assets when they are passed on. In contrast, an inheritance tax is imposed on the beneficiaries themselves, based on their receipt of the assets. There is a federal estate tax, but no federal inheritance tax. Only five states impose an inheritance tax, but 12 states and the District of Columbia impose an estate tax.
Conclusion
The inheritance tax can be a significant burden for beneficiaries. It is essential to understand if it applies to you, how it works, and the different strategies that can be used to reduce or avoid it. By understanding the differences between inheritance tax and estate tax, as well as the specific rules, individuals can plan to minimize the amount of taxes their beneficiaries will have to pay.
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